MODULE 8
INTRODUCTION TO
CORPORATE FINANCIAL
GOVERNANCE
ADB Private Sector Development Initiative
Corporate and Financial Governance Training
Solomon Islands
Originally by
Dr Judy Taylor
Acknowledgement
These materials were produced by Dr Judy Taylor from La Trobe University, through the Asian Development Bank’s
Pacific Private Sector Development Initiative (PSDI). PSDI is a regional technical assistance facility co-financed by the
Asian Development Bank, Australian Aid and the New Zealand Aid Programme.
Module 8 Outline
3

Introduction to corporate finance governance
 Meaning
 Why
of financial corporate governance
is financial corporate governance important?
 Financial
statements and accounting records: the legal
rules
 How
to undertake financial planning for your business
Meaning of Corporate Financial
Governance
4
What is financial corporate governance?

Financial corporate governance relates to the
financial obligations and responsibilities of a
director. It is a sub category of corporate
governance and matters applying to that also
apply to corporate financial governance
Corporate Financial Governance
Financial corporate governance is a two-step process
 internally determined governance rules to comply
with
 externally imposed governance rules
 government
 They
 debt
regulations through Acts of Parliament.
are also imposed by:
covenants by credit providers; and
 competition or market regulation.
Financial responsibilities of directors
In summary, directors of private companies, public companies and
community companies are responsible for the financial management
and reporting of the company. Even where professional managers are
undertaking the day-to-day tasks it is the directors who are ultimately
responsible. The directors are responsible for the systems in place that
record report and protect the financial integrity of the organization.
An important duty we will revisit is the duty not to trade while insolvent.
Directors in the Solomon Islands must ensure that proper accounts are
kept in writing or can be easily transferred to written form, that they
are held for seven years on company premises.
The duties of the directors include ensuring that the financial records
are maintained properly and that falsification is avoided and can be
easily detected.
Financial responsibilities of directors
In addition companies must file an annual report with the Registrar as
well as send a copy to the shareholders, if they are a public company
or if requested by shareholders if they are private company.
Directors have a duty to ensure that the financial statements reporting
conforms with those set out in Schedule 3 of the Regulations 2010 and
in a manner defined by Regulations 8-10.
The accounts should be compiled using the accrual accounting system.
In addition guidance is given in relation to the treatment of accounts
receivable, depreciation, inventories and non-current assets. A public
company must comply with IFRS or state how and why they so not
comply.
Internal control
“A process, effected by an entity’s board of
directors, management and other personnel, designed
to provide reasonable assurance regarding
achievement of objectives in the following categories
(i) Effectiveness and efficiency of operations,
(ii) reliability of financial reporting,
(iii) and compliance with applicable laws and
regulations.”
COSO 2005 in Ahmed Naciri, Internal and external aspects of corporate governance, (2009, Taylor and Francis), p 109
How do companies comply?
Internal controls identify and design processes to
manage risks so that the organisation has control over
how its resources are:
 directed, through the strategic plan and budget;
 monitored, through internal audit, compliance and
risk management; and
 measured, through the compiling of accounts.
Business success not guaranteed
However internal control does not ensure the success
of an organisation or make poor mangers into good
ones.
 If
the strategic plan is weak,
 If the competitive environment is difficult, or
 if the organisation does not have enough liquid funds,
the business could still fail.
How to establish Internal Control
Subcommittees:
Effective working subcommittees are an essential
ingredient in establishing good financial governance.
Sub-committees facilitate action rather than just
discuss direction. Sub-committees should also facilitate
information sharing among directors so that decisions
are made with everyone’s knowledge and comply
with business plans or constraints.
Sub-committees
strategic planning,
• budgeting and finances,
• internal audit,
• compliance and risk management,
• remuneration and HR,
• techinical
The list and structure of subcommittees will vary from
company to company.
•
Financial Governance
ABoard of
Directors
Financial Planning,
Reporting and
budgeting
Human
Resources
Technical
Audit
compliance
and risk
management
Chief Financial
Officer
Budgeting
and
Planning
Receipts
Payments
Financial
Reporting
Overview of financial governance


The board sets up a financial, planning reporting
and budgeting committee
The Chief Financial Officer then devolves these
duties into a number of separate areas which
ensures a system is in place to record, verify and
measure free of fraud (one model does not fit
every organization)
 Budgeting
and planning
 Day to day financial tasks (management accounting)
 Reporting
Strategic planning
Every board of directors should construct a rolling 5 year plan
that sets out the plan for the company.
 reviewed annually and adjusted as the conditions require.
A basic business plan has several key elements:
 Executive summary
 Description of the business
 Description of the target market
 Analysis of the competition
 Description of the management team
 Marketing strategy
The strategic plan becomes a measure of the effectiveness of
the directors and management team because the outcomes of
the plan and the targets are reported annually
Financial Planning and Budgeting
The budget translates the strategic plan into financial units.
It is an integral part of the strategic plan and helps to
determine if the plan is viable by putting financial figures on
its implementation.
Key skills that directors require to be able to establish and
monitor finances as required by law are
• Develop a budget
• Review a budget
• Analyse any variation
• Convert actual outcomes to financial reports
Financial Planning and Budgeting
For this to happen procedural manuals must be
written, implemented and their correct usage
monitored. This work will be done by employees of
the company under the guidance of the Finance
subcommittee.
Creating, monitoring and managing the budget is a
key to business success, though it does not guarantee
it.
How to develop a Simple Budget
Begin by asking these questions:
•
•
•
What does my plan project?
What is my projected revenue?
What will it cost us to produce them?
Simple budget
What does my plan project?
Launch a new product and sell 1000 items
What is my projected revenue?
What will we sell them for? $3 each
Total projected revenue
What will it cost us to produce them?
Fixed costs per annum
Rent
Electricity
Management salary
Variable costs
Material inputs - $1 per item, for 1000 pieces
Manufacturing wages
Total costs
Profit

$3* 1000 =
$3000
200
100
400
700
1000
500
1500
$2200
$ 800 (27%)
Simple budget
•
You must know your business.
•
•
•
You need to know what each item will cost in materials.
If materials cost $1.8 there will not be a profit
What happens if you sell only 750 items not1000?
Having a budget does not guarantee that the business
will succeed. It shows what will happen if your
assumptions are correct and the world behaves as you
have planned. The more informed you are about your
business, the more accurate the budget, and the more
likely your business will make a profit.
Simple budget - revised
21
What is my projected revenue?
What will we sell them for? $3 each
Total projected revenue
What will it cost us to produce them?
Fixed costs per annum
Rent
Electricity
Management salary
Variable costs
Material inputs - $1 per item, for 750
Manufacturing wages
$3* 750 =
$2250
200
100
400
700
750
500
1250
Total costs
$1950
Profit
$ 300 (13%)
Complex budget
•
•
•
What does my strategic plan say?
Will one budget cover all my needs?
How many budgets will I need?
•
•
•
•
Manufacturing
Purchases
Staff
Asset management
Designing my budget
There is no universal budget model that fits every business.
Different business and different industries will have
different revenues and expense categories.
If a line item must appear in the annual accounts then it
must also be included in the budget.
The chart of accounts that is developed for internal
financial reporting purposes should also be used for
developing the budget.
The first budget is the most difficult. In the second and
subsequent years you can use the first actual year of
expenditure and revenue performance as a benchmark.
Who needs to be involved?
•
•
•
•
Budgeting subcommittee
Chief financial officer
Managers of each division
People who produce the items
Steps to develop a detailed budget
7 steps - constitute a loop
• Step 1. Revenue
• Step 2. Production Direct Costs
• Step 3 Other administrative Expenses
• Step 4 Fixed costs
• Step 5 Bottom line
• Step 6 Repeat steps 1 to 5
• Step 7 Cash Flow
Step 1. Revenue
The Strategic plan/business plan should help in
establishing the projected volume of revenue/sales
and the pricing of those services.
• Note the planned volume of sales.
• How do you set the price?
•
•
What will the market bear
What is the competitive environment
The revenue needs to be reviewed repeatedly once
all the costs are known.
Step 2. Production Direct Costs
Cost of materials or purchases
•
This can be estimated simply if only one or a few products are produced.
•
If the number of products is large, then there should be a separate manufacturing
budget. This budget would include each item produced, the volume of the item used
per unit and the price of each input. For example if you make toys such as rubber
animals, the items that would be included are
•
Moulds - including how many items each mould can produce
•
Rubber – the amount poured in and the amount poured out
•
Stuffing – used inside the toy to give it shape
•
Wire – to help big toys stand up
•
Paint – the amount of each colour of paint used to finish the toys
•
Staff – the amount of staff time in each area to produce each toy
The first year these numbers will not be known. They are estimated. They are estimated
with input from workers, testing and experience in other firms. The second year costs
are easier to estimate and usually reduce with production experience.
Step 3 Other administrative Expenses
•
•
These include the running costs of the organisation that are
not part of the production process.
They include: accounting fees, advertising, amortisation
(patent or goodwill impairment), audit fees, bank charges,
board costs, client support, donations, computer costs,
consultancy costs, depreciation (building, motor vehicles,
plant and equipment), motor vehicle costs, insurance, interest,
legal fees, management expenses, printing and stationery,
rates and local taxes, repairs and maintenance, salaries,
staff benefits, workers compensation, sundry expenses,
telephone and communication costs, training costs- staff and
management, travel - local and international, utilities,
volunteer costs, taxes.
Step 4 Fixed costs
•
•
Fixed costs and overheads are those costs that do
not vary with the number of units produced.
These include rent, managers’ wages and leases.
Even if the business produces nothing these costs will
be incurred and cannot be avoided.
Step 5 Bottom line
Once the board is satisfied with projected
expenditure figures, item pricing can be set in line
with competitive environment and a profit can be
projected.
Step 6 Repeat steps 1 to 5
If no profit is possible at this level then the plan is not
viable and the board needs to decide whether to try
to:
1. increase volume if there is demand and so reduce
the price they sell at, or
2. focus on reducing production costs of each item.
Step 7 Cash Flow
Businesses fail because of cash flow problems.
It is important to devise a monthly cash flow budget
as well as an annual budget. This will ensure you can
pay the wages, rent and interest.
CASH is KING!
Cash flow budget allocates income and expenses to
the period when they happen.
Vanity, Sanity, Reality
33


Too often business owners are fixated on the sales
of a business which is all about vanity but net profit
(or your sales less your expenses) is your sanity.
Even more important is your cash flow or whether
you have the money to pay your staff, your
suppliers and yourself which is reality.
No matter how successful your latest sales push has
been or how much profit you have made, nothing
brings you down as effectively as a cash flow crisis.
Operate within budget
When the budget is complete, every effort should be
made to operate within it.
It will need to be reviewed and revised regularly to
allow for any contingency.
Successful businesses often have a rolling budget
aligned with their strategic plan, so that they are
continually budgeting for at least a year in advance
and forecasting 3 or 4 years.
Budget vs Forecast
35
The key difference between a budget and a forecast is that the budget
is a plan for where a business wants to go, while a forecast is the
indication of where it is actually going.
Realistically, the more useful of these tools is the forecast, for it gives a
short-term representation of the actual circumstances in which a
business finds itself. The information in a forecast can be used to take
immediate action. A budget, on the other hand, may contain targets
that are simply not achievable, or for which market circumstances have
changed so much that it is not wise to attempt to achieve. If a budget is
to be used, it should at least be updated more frequently than once a
year, so that it bears some relationship to current market realities. The
last point is of particular importance in a rapidly-changing market,
where the assumptions used to create a budget may be rendered
obsolete within a few months.
http://www.accountingtools.com
Review performance against budget
Although the budget is prepared annually is should be
reviewed monthly or quarterly.
• At the end of each month, the board needs to compare the
actual results of revenue and expenditure with the budgeted
results; variances need to be noted and explained.
• The variances should be categorised as either a 'timing' or
'permanent' variance.
• a timing variance is where the estimated result did not
occur but is still expected to happen at some point in the
future
• a permanent variance is where the expected event is not
likely to occur at all.
Reviewing budget
Budget
Revenue
Actual
Variance$
Variance%
$3* 1000 =
$3000
2000
-1000
-33%
200
100
400
700
210
100
400
710
+10
0
0
+10
5%
0
0
1.5%
1200
500
1700
+200
0
+200
20%
0
13.3%
Fixed costs per annum
Rent
Electricity
Management salary
TOTAL FIXED
Variable costs
Material inputs (1000 pieces)
Manufacturing wages
TOTAL VARIABLE
1000
500
1500
Total costs
2200
2410
+210
9.5%
Profit
800
-410
-1210
-51.25%
Why have the actual amounts varied
from the budgeted amount?
•
•
•
Revenue is down 33% from the projected amount.
WHY?
The committee might report that the departure from
projections is due to
•
Orders slow- due to an unforeseen event like flooding,
•
•
but that since the month’s end orders have already exceeded the next
month’s projection, so the difference is due to the timing of orders, not
due to a decrease in orders over the projected year. This is a timing
difference and it will be resolved in the next reporting period.
Entry of a new competitor in the market.
•
This competitor might have new, more efficient, technology that allows
them to produce at a much lower cost and sell at a lower price. This
would render the company’s current price high compared to the new
competitor, and should trigger a significant review of the business.
This is a permanent difference that needs serious planning.
A budget as a measure of performance
•
When the budget is reviewed for variance it can
also be reviewed for outcomes of the plan.
•
•
monthly budget reviews become planning performance
This helps the board achieve better control over
their plan, to set realistic and achievable targets for
management, and to provide control over
expenditure and profitability.
Other internal control checks
•
•
The internal audit committee is responsible for
reviewing whether the staff, management and
board are complying with established internal
procedures and whether the accounts presented to
the board are reliable, accurate and honest.
The compliance committee, will support the internal
audit committee by ensuring that the accounts
comply with the requirements set down in
Companies Act. Often these responsibilities are
combined so that there is only 1 committee.